The Grand Bargain is unraveling, and a new arrangement will take the place of the
Status Quo--whether we like it or not.

Correspondent Arnold suggested that I address the fiscal cliff, so here goes.

The first step is to set aside ideological blinders and confirmation bias, i.e.
only looking for data that supports our current beliefs.

The second step is to look at the foundation of everything: household income.
Household income is the foundation of taxes paid, consumption (spending) and
savings/investment. If household income is declining, that means the pie of money
that can be divided up into taxes paid, consumption and investment is shrinking.

If taxes go up, there is less pie left for spending or investment. And since the
economy ultimately depends on private-sector spending and investment, then reducing
those to fund government spending means there will be less private spending and
investment.

If the government spent the taxes on investments that yielded a higher return than
private investments, higher taxes would not devastate the economy. But the problem is
that there are no feedbacks on government spending that favor efficiency or
high yields.

Government spending decisions are made solely on the basis of constituency pain:
the constituencies that create the most political pain for politicos and
Upper-Caste government bureaucrats get funding. Efficiency and high-yielding
investments are not in the political equation at all; there is no feedback in
monopolies except those that favor expansion of budgets and constituencies.

Here is another chart depicting the huge gap between nominal income and real income:
while nominal income rose a seemingly healthy 25% since 2000, real income has
declined almost 10%.

Median income doesn't tell us who is getting most of the income, so let's look at this:
All the increases in income since 1970 accrued to the top 10%.

But we have to remember that median income includes all income, including the wealthy.
Real income has declined by 8%-9%. The pie is smaller, period.

Some of that is due to a declining full-time workforce, which has dropped to 115 million
workers:

Now let's look at the size of government spending and taxation. In terms of
the overall economy (GDP), government spending's share of the economy has been rising
for decades. The Internet and housing bubbles briefly "grew" the economy faster than
government spending, but once these one-off expansions faded, government spending quickly
returned to its trendline (ever higher).

Federal spending rose exponentially until it exceeded the carrying capacity of the economy.
For context, recall that Social Security costs $817 billion, Medicare and Medicaid costs
total about $800 billion annually, and the Pentagon/National Security budget is
around $690 billion. Add in interest on the ballooning national debt, and the vast
majority of the Federal budget goes to these four. You could eliminate all other
Federal spending and these four consume all the tax revenues and then some.

OK, so now we see why government spending can't keep following an exponential
path higher: households are earning less income.

Next up: the welfare/cartel State. Some welfare flows directly to individuals
("transfer payments") and some flows to cartels: defense, sickcare, the education
cartels, etc.

The problem here is the number of citizens who are dependent on government
transfers and spending now exceeds the number of full-time workers.
Recall (see chart above) there are 115 million full-time workers in the U.S.

100 million wage earners, or 2/3 the entire workforce, earn less than $40,000 per year.

In practical terms, only the 115 million full-time workers pay significant taxes,
and of those, The top 25% (those earning more than $66,193) paid 87% of the taxes.
The bottom 50% of taxpayers, roughly 70 million people, earned 13% of the income and
paid 2% of the income taxes collected.

(The top 1% of taxpayers reported almost 17% of all taxable income and paid 37% of
all income taxes. The top 5% reported 32% of all income and paid 59% of the taxes,
and the top 10% earned 43% of the income and paid 70% of the taxes.
Where Do You Rank as a Taxpayer?)

The top 1/2th of 1% owns most of the productive assets of the nation and
most of its machinery of governance (this is the "half class"). Most of the income
not siphoned off by this
"we own the important stuff" class goes to the next 19.5% who pay most of the Federal
taxes (class #1).

Class #2 is the dwindling "middle class" (also known as the working poor)
which receives no government transfers and lives off earned income. This is perhaps
30% of the households.

Class #3 is the lower 50% who depend on transfers, subsidies, etc. because they
are retired, don't make enough at their jobs to support their families or are
disabled (legitimately or otherwise).

The Grand Bargain was this: we at the top will pay significant taxes as long as we
get to control the levers of financial and political power. We in the top 19% will
pay much of the taxes as long as we and our children can continue to live well
and accumulate wealth. We in the "middle class" will continue to work hard as long
as we have hope of bettering our lifestyle and the lives of our children. We in the
bottom 50% and retirees agree not to threaten the top .5%'s power and the wealth of
the top 19% as long as we can get by on our government transfers.

This Grand Bargain is now fraying as the promises made to everyone cannot possibly
be met. Claims on welfare and disability programs are skyrocketing at the same time
that the demographics of an aging populace are causing 10,000 people a day to enter
Social Security and Medicare, the two costliest government programs. The triple-whammy
is the upper-middle class that pays most of the taxes has been slammed with lower
income and a devastating drop in their net worth.

That which is unsustainable will be replaced by another more sustainable arrangement.
Everyone who slips off their ideological/self-interest blinders knows
the Status Quo is unsustainable, and so everyone in the 3.5 classes is shifting
nervously: will I get taxed to the point of "uncle" or will my bennies get slashed?

By heavily taxing earned income, the system extracts the
highest taxes from the most productive citizens, leaving the less-productive with
essentially no income taxes and the super-wealthy with the huge tax break offered
to capital gains and other unearned income.

In essence, this is a vote-buying scheme by the Status Quo: the top .5% control
the policies of the State in alliance with the State's own Elites, and together
they buy the complicity of the bottom 50% to passively accept their dominance.

In other words, the bottom 50% pay relatively modest taxes or are recipients of Central
State aid and the top .5%
who "own" the political process limit their taxes by favoring
unearned income (what they collect from sales of securities, stock options, rents, etc.).
Thus the productive quintile (top wage earners) pay the highest tax rates
and most of the taxes.

It's a partnership of "Tyranny of the Majority" and "entrenched incumbents Elites."
If the political Status Quo alienates the majority by making them pay more taxes, they
risk losing power in the next election. If they alienate the top .5% who fund their
multi-million-dollar campaigns, then they will also lose power. So they heap the tax
burden on what remains of the upper-middle class.

When that 20% rebels, falters or opts out, the system collapses for want of
tax revenues. Not coincidentally, that happens to fit the Pareto Distribution: the 20%
"vital few" exert outsized influence on the 80%.

The Grand Bargain is unraveling, and a new arrangement will take the place of the
Status Quo--whether we like it or not.

Things are falling apart--that is obvious. But why are they falling
apart? The reasons are complex and global. Our economy and society have structural
problems that cannot be solved by adding debt to debt. We are becoming poorer, not
just from financial over-reach, but from fundamental forces that are not easy to identify
or understand. We will cover the five core reasons why things are falling apart:

Complex systems weakened by diminishing returns collapse under their
own weight and are replaced by systems that are simpler, faster and affordable. If
we cling to the old ways, our system will disintegrate. If we want sustainable prosperity
rather than collapse, we must embrace a new model that
is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of
the same coin: once we accept responsibility, we become powerful.

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